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Tracking Stock for Utilities: Highway to Higher Valuations?

Fortnightly Magazine - April 1 2000

high-yield bond market for financing. A tracking stock linked to a utility's deregulated generation business, and targeted to investors with a greater tolerance for risk, might offer a cheaper source of equity financing.

A Larger Carrot. A stock linked to its deregulated generation business may give a utility more valuable currency, not just for acquiring assets but also for compensating its employees. Utilities are discovering that managerial talent for their deregulated businesses is at a premium. Along with other "Web-less Wonders," utilities are finding it difficult to compete for a limited pool of qualified personnel with dot.com startups and the lure of instant stock market riches that they offer. Several companies that have recently issued or are preparing to issue tracking stocks, including Sprint, AT&T, and Global Crossing, have cited as a primary motivation the perceived need for a more richly valued stock that they can use in incentive-based compensation. Options on a stock that tracks its deregulated business may ease a utility's burden in attracting, retaining, and motivating employees.

Stranded Costs: A Way to "Cash Out"

While many of the gains that telecommunications and other companies have reaped from tracking stocks may be universally applicable, issuing such securities may afford unique advantages to utilities during the transition to competition. Utilities in jurisdictions that will adjust stranded-cost awards to reflect asset sale prices or allow sales only if gains are shared with ratepayers would, in effect, have all surplus from any asset divestiture expropriated. Such a utility that does wish to sell all or part of its generation asset portfolio could, instead, create a class of tracking stock that is linked to the performance of these assets. The utility could then sell shares of this tracking stock in a public offering. The stock offering would allow the utility to monetize a portion of the cash flows associated with its generation assets without affecting the size of its stranded-cost recovery or violating any divestiture restriction.

Securitization by another name. Tracking stock also may offer a way out for utilities in states that have not enacted laws that enable securitization of a competition transition charge (CTC). These utilities will actually receive their stranded-cost recoveries over transition periods that could be as long as five to 10 years. Though the CTC would be collected from a utility's distribution customers, it would constitute compensation for the loss in value of the utility's generation assets caused by deregulation. Therefore, the income stream that the CTC represents would belong to the utility's generation segment. A utility that issues a generation tracking stock would allocate to its generation group its generation assets as well as the rights to recover all stranded costs associated with them. As a result, the generation tracking stock's price would reflect the utility's entitlement to receive a stranded-cost recovery in the form of a CTC from its distribution customers. If the utility issues and sells additional shares of this generation tracking stock, it would capitalize a part of the uncollected stream of CTC payments. In effect, a generation tracking stock would allow the utility to